Packaging Corp of America (PKG) 2006 Q2 法說會逐字稿

Good day, ladies and gentlemen. Thank you for joining Packaging Corporation of America's second quarter 2006 earnings conference call. Your host today will be Paul Stecko, Chairman and CEO. Upon conclusion of the narrative, there will be a question and answer session. (OPERATOR INSTRUCTIONS). As a reminder, this conference call is being recorded. I would like to now turn the conference over to Mr. Paul Stecko.

Thank you and good morning. And welcome PCA's second quarter earnings release conference call. With me on the call today is Mark Kowlzan, who runs our mills; and Rick West, our Chief Financial Officer. And thanks for taking the time to participate. As the operator just as said, when we conclude the formal presentation we will be more than happy to take any questions that any of you have. Let me get right into it.

Today we are reporting second quarter net income of $32 million or $0.31 a share. This compares to first quarter 2006 net income of 9 million or $0.09 a share, and second quarter 2005 net income of 28 million or $0.26 a share. And that included a $0.06 per share dividend paid from Southern Timber Venture, a timberlands joint venture which PCA holds a 31% ownership interest.

Without the STV dividend earnings were off $0.11 a share over last year's second quarter, and up $0.22 a share over this year's first quarter.

Net sales were $551 million. That is up 6% compared to $519 million last year. Net income for the first 6 months of 2006 was $41 million or $0.40 a share, and that compares to 40 million or $0.37 a share in 2005, including the $0.06 STV dividend.

Net sales for the first 6 months of 2006 were 1.06 billion, and that compares with 1.01 billion for the same period last year.

The $0.11 per share increase in earnings, excluding last year's STV dividend, was driven primarily by higher pricing and volume for both containerboard and for corrugated products, which amounted to an improvement of $0.23 a share. These earnings improvements were partially offset by higher transportation and purchased energy costs of about $0.07 a share, and some other items totaling about $0.03 a share, which we will get into in more detail a while later in the presentation.

In addition, the delay over of our maintenance outage for our Valdosta mill until the second quarter this year reduced earnings by about $0.02 a share.

Compared to the first quarter this year our earnings were up $0.22 a share from $0.09 to $0.31. This improvement was driven primarily by, again, higher pricing and volume up $0.20 a share, and lower purchased energy costs of about $0.04 a share.

By July 1 we essentially completed the pass-through of our April containerboard price increase to boxes, which by historic measures represented a faster than normal pass-through for us. And quite frankly it was a little quicker and turned out to be a little larger than I originally anticipated entering the second quarter. This, along with just simply superb mill and box plant operations allowed us to report results today that are much higher than our previously issued guidance.

Compared to our original guidance of $0.22 a share for the quarter, price and volume were $0.07 a share better than we originally expected. Energy was $0.02 a share better than expected, and other variable costs were $0.01 a share better than we originally projected. With the only negative being recycled fiber cost, which were about $0.01 a share worse than we originally anticipated.

In addition, after we issued our earnings guidance, there was a May 2006 change in Texas state law tax that created a favorable adjustment for us to our tax liabilities and lowered our effective tax rate for the second quarter. This improved our earnings by about $0.015 per share.

On the box plant side of our business, our volume remained strong with corrugated products shipments up 2.1% per workday compared to last year's second quarter, and for the year were up 1.8%.

On another positive note we completed annual maintenance outages at both Valdosta and Tomahawk on schedule, and both mills started up extremely well after these shutdowns. Valdosta was down for a total of nine days and Tomahawk was down for four days. During this time we had, of course, lower production and higher operating costs at those mills.

For the quarter our mill production was 592,000 tons, which is about 6,000 tons or 1% higher than last year's second quarter. This higher production, in spite of Valdosta being down, was a result of outstanding operations across our entire mill system.

As I think many of you know, we had to delay this year's Valdosta outage from February until April in order to keep inventories at levels necessary to support our box plants during the first quarter. Also, since April had only 19 workdays in the box plant because of holiday schedules, having Valdosta down for maintenance then was the least disruptive on our inventories.

We ended the second quarter with our containerboard inventories down 3,000 tons compared to the end of the first quarter of 2006, and we are down about 18,000 tons from year-end 2005 levels. As we enter the normally stronger part of the year for box shipments, it is good for us to have essentially all of our annual outages behind as, except for a small three to four day outage scheduled for Filer City in the fourth quarter.

The FBA also reported yesterday that industry shipments per workday for June for the industry were up 4.9% over last year, and industry inventories fell another 11,000 tons to 2.37 million tons. This represents the third lowest end of June inventory since 1981. That is 25 years ago. And for the quarter industry shipments per workday were up 4.7% over last year. And from our prospective this is all very, very positive news.

Looking now at second quarter cost in a little more detail, higher energy costs for both purchased fuels and electricity did lower earnings by about $0.04 a share compared to last year. However, compared to the first quarter of 2006 our energy costs were down about $0.04 per share. And what is amazing about this from our perspective that is even after having to burn additional natural gas at three of our four mills as the result of plant boiler outages, including a 40 day outage on our large coal boiler at Filer City for a complete retubing.

Now we did run extremely well on our mills. When you can do that, it really helps your energy consumption. And that is one of reasons that I think we performed so well costwise.

And as I think you know, PCA is much, much less affected by higher natural gas and oil prices than virtually anyone else in the industry since 80% of our purchased energy comes from much lower-priced bark and coal.

Transportation costs, unfortunately, remained high, up about 12% compared to last year's second quarter, and that lowered earnings by about $0.03 per share year-over-year.

Finally, I would like to conclude by looking at a few items which in total, as I said earlier, lowered earnings by about $0.03 a share in total compared to last year's second quarter. These items included higher labor costs from normal wage increases of about $0.02 a share; higher benefit costs for such things as medical, pension, worker's compensation, etc., of about $0.02 a share; the change in accounting treatment for expensing stock options of about $0.01 a share; higher interest expense of about $0.01 a share; and reduced wood products profit of about $0.01 a share. We do have two small sawmills.

Partially offsetting these items was a lower effective tax rate of 35% in the second quarter of 2006 compared to 41% in the second quarter of 2005, and about 38% in the first quarter of 2006.

Our overall expected effective tax rate for 2006 was about 38%. So in the second quarter our earnings improved by about $0.015 compared to the second quarter of 2005, driven by lower tax reserve requirements and increased manufacturer's deduction credits, which is part of the new tax law, which we will continue to enjoy.

In addition, as I mentioned earlier, our effective tax rate dropped another 2.5% in the second quarter, which improved earnings another $0.015 as a result of this onetime adjustment from the change in Texas tax law. You take all that together it is $0.03.

Recycled fiber costs were up about $20 a ton compared to the first quarter of 2006 levels of about $0.01 a share, but still down about $5 per ton compared to last year's second quarter. Wood fiber costs were essentially flat compared to last year.

Moving next to cash and cash utilization, our capital expenditures were $23 million for the quarter. We ended the quarter with cash on hand of 94 million, and that is up 26 million from the end of the first quarter. Our long-term debt was 696 million. And our cash interest rate on all of our debt for the quarter averaged 5.4%.

In summary, we had a very, very strong quarter operationally. We completed the pass-through of our April containerboard price increase, the boxes even sooner than we expected and with good price realizations. We achieved another quarter of year-over-year corrugated product volume growth. And our mills ran extremely well with our annual outages and boiler repair work done on schedule, and then followed by very good startups.

Looking ahead to the third quarter, we expect continued earnings improvement, driven for the most part by the full realization of the second quarter corrugated product price increases. And again we will get it all in the fourth quarter. We obviously phased it in during the second quarter.

Purchased energy costs should be down slightly from the second quarter, unless natural gas and oil prices escalate from hurricanes or other events that are going on in the world right now that affect oil. And maybe the biggest affect of this could be an increase in transportation costs. But we haven't factored much in for that, and hopefully it won't happen. We do expect OCC prices to move a little higher in the third quarter. Considering all these items, we currently expect earnings to be about $0.42 a share in the third quarter.

With that I would be happy to entertain any questions, but as always, I have got to remind you that some of the statements we have made on this call constituted forward-looking statements. These statements were based on current expectations of the Company and do involve inherent risks and uncertainties, including those identified as risks factors in our annual report on Form 10-K on file with the SEC. Actual results could differ materially from those expressed in these forward-looking statements.

With that I would ask the operator to open the phone lines, and we would be glad to take any of your questions.

(OPERATOR INSTRUCTIONS). Edings Thibault from Morgan Stanley.

Congratulations to your organization on the delivery of the pricing and the operating rates here. Great news.

I wanted to ask a couple of things. Number one, you mentioned that price increases were going through more rapidly in the box side than you have anticipated. I wonder if you could put that in historical context and perhaps talk a little bit about why you had anticipated the prices would take longer, and then perhaps any insight you might be able to provide on why they appear to be appearing more rapidly.

Sure. Let me put this in a little, as you said, historical perspective. Normally for us, and we have less I would say long-term contract business than others in the industry. We have a lot of local business, so shorter duration. That gives you some ability to not have to wait a quarter or two quarters in some case to raise prices.

But it normally takes us about three months to put through a price increase. That would be the historic measure. If you look at the industry, I don't really the number, but it is probably four months, five months, I don't know, but it is in that timeframe. I think that is related a little bit to the structure of our business.

We basically got these last two increases through in two months, which is about a 33% improvement. There're a lot of reasons, but if you really get down to it, it is our job to do that. Raising prices is part of your job. A lot of people concentrate on -- they only hear and talk about managing costs. That is important too, but raising prices is also very important and we work very hard at it.

We have a system in place. We have got 8,000 pieces of business. Every one of those pieces of business we had a target price increase in mind, when we would get it, how we would get it. Look at it every week and manage it, and then measure how we did against those expectations.

Things you manage every day you tend to do a lot better than things you manage once a month or once a quarter. We manage this every day, and i think that is part of the reason. So we're pretty pleased.

And why did we do better -- we did a better job than I thought we would do? And I had high expectations of doing a good job. I'm very pleased. Bill Sweeney and his whole team deserve a lot of credit. They worked real hard on these last two price increases. And hey, as I told them, it is your job.

Good to hear. Thanks. Then just a few housekeeping questions before I let you go. Your expected effective tax rate for the full year now? And also I was wondering if you could just comment on the operating performance at the mills. How you would rate your operating rate relative to the rated capacity of your machines? Did you effectively run full for your available days?

Yes. We ran basically at 100%. Our operating performance -- year-over-year if you adjust for the fact that we moved Valdosta shutdown into the second quarter this year from the first, and that is about $0.02 a share. If you make that adjustment, and just take that into account, year-over-year our operating cost in the mills is essentially flat, which is pretty good.

Because it was before we had the big run-up in gas prices last second quarter, so we have been able to run basically with flat costs in our mills. That is excluding transportation. Part of the reason for that is that we ran so well and very, very efficiently. Quite frankly, Mark Kowlzan, who was on this call with us, he was under the gun. We had to run to keep up with our inventory levels. We still lost 3,000 tons in inventory during the quarter.

So very good operations at essentially 100%. We should have been 102, but hey, we will try harder next quarter. We need the tons. We're running on empty.

For the tax rate, for the full year we still expect about 37.1%, taking into account the 35% the second quarter. We would expect to see the third quarter and the fourth quarter at about 37.5 to 37.8% for the effective tax rate.

Mark Connelly from Credit Suisse.

Just a couple of quick things. First, your volumes versus the industry, can you give us a sense of whether there was anything unexpected there -- unexpected by you? And second, the inventory question, are you concerned about inventories being low going into this strong part of the year? Remember we had that trouble a year or so ago.

Let me take those one at a time. Our volume was up over last year's all-time record second quarter. But we weren't up as much as the industry. And I think there is -- from my perspective I'm pretty happy with that volume.

One, we only had so much paper to sell. And so that affected our ability to grow the business, because one thing that we -- we have a lot of business where we are 100% supplier with our customer. And our customers at this point, a lot of the psychology of buying has shifted from supply assurance -- not that price still isn't important -- but that has become a big concern.

You've got 100% of somebody's business, you've got to look them in the eye and tell them you're going to be able to support them. We were a little conservative on any business that we take on until our inventory situation is a little better.

Number two, quite frankly, as I told the previous caller, we had a plan to raise the prices. If you're going to raise the price, you better understand that you are probably going to lose a little business here and there. If you don't lose a little business here and there then I don't think you have been aggressive enough on price. So that happens also. But they were the two primary reasons. But in terms of where we are, I'm pretty pleased with our volume.

With regard to the last question, which is -- refresh my memory on that, the one I missed?

The inventories.

Oh, the inventories.

Strong time of year.

Let me tell you, we got a little help at the nick of time. I was never happier in my life to have a Fourth of July holiday. Although we dropped 3,000 tons, we got a break in that the first four days of July are not box plant operating days. It was a Sunday, Monday and then the two Fourth of July holidays. So we had four days where we could put some more containerboard into the system.

And the other bit of good news is that the month of July has only 19 box plant workdays, but 31 mill production days. We will be able to build some inventory in July, which is critical for us, because the behind July is August that has 23 box shipping days. And then you've got two big months behind that, September and October, where you're into peak demand.

Mark Kowlzan and his team are under the gun again. They have got to have a big July to support us for the next three months. And the good news is we're off to a real good start again in July in our mills. I think we're going to be okay, but we're not completely out of the woods.

Perfect. Very helpful. Thank you.

Rich Skidmore from Goldman Sachs.

Just to follow-up on the question on July, can you talk maybe about what you have seen so far on the box demand in July so far? And then just a second question on the price. When you mentioned you essentially raised the price to the boxes, is that the full 50 or the full 8 to 10%?

Let me take the last question first. The only people we talk to box prices about are our customers. And so the only thing I can say is that we will achieve the full pass-through on the $50, and leave it at that. The second question on -- what was your first question?

Essentially what you have seen so far in the month of July.

Yes, okay. I wish you hadn’t asked that question, but I'm going to answer it anyway because it may be misleading, and so I'm going to take a little time. I usually tell you how we have done the first, I guess, seven workdays into the month.

It is very misleading data. I want to say that right away. Because last year the way the Fourth of July fell it was a bad July. The data will look better than it is. Through the first seven days our bookings are up 12%. And we have -- our billings are up 9% over last year. Now they're big numbers. But the first day of July last year was terrible. It was a Friday before the Fourth of July. So you've got to discount that a little bit, and that is hard to do.

If I discount it, and just throw that data away and pretend it never happened last year, we are up a little over 6% and up a little over 3% in July. So still pretty good, but if you look at the raw numbers I think it will mislead you a little bit.

Essentially just following up on that, you're not really seeing anything that would suggest any slowing in your business?

No, not all.

And then just lastly in the export markets is there any ability for you to be bringing volume back in the export market to improve your inventory situation domestically, or is the pricing such in your export market that you're better off there?

Well, you never say never. We have pulled out of export to some extent. But what we have pulled out is spot tons. We still have long-term customers in export that we will continue to service. I don't have -- the cupboard is almost bare there also in terms of one I can pull out of export.

We're going to have to build inventory the old-fashioned way, and that is the mills have got to run well. Quite frankly, I wouldn't mind putting a few tons back into export because I think we have some good opportunities there. We have some people interested at good pricing, and the freight is terrific in the export because you have only got to deliver FAS to the port. But I've got to build some of those tons.

You can see exports, I think if you look the June numbers were down another 20,000 tons. That is not because the export market is bad, that is because there is not a lot of tons available to go into export. I wish I had a few more tons I could put in there. My goal is not to take any more out of export. I want to support customers that we have had for a long time.

George Staphos from Banc of America.

Maybe piggybacking on that last question, there's an article today on the front page of the Journal talking about U.S. manufacturers exporting a bit more than in the past. I realize you're a little bit more local, but have you also seen it from some of your customers, are they anecdotally talking about a greater ability to hit in these markets given the depreciation in the dollar?

And then a separate question. Just on end markets again, I realize a very diverse series of end markets for you, but are there any end markets that seem particularly robust for you at the present time? Then I had a couple of follow-ons.

I don't think there's any particular end market that just jumps out at being more robust. I do have a feeling, and this is only a feeling, I don't want to sound like I know more than I know. But with high gasoline prices I just have a feeling that there's a lot more "Internet" type commerce, or people maybe buying things that they get shipped to them as opposed to having to drive somewhere for them. And that adds another corrugated container in the process.

I think when you look -- I saw FedEx yesterday had good results. I think that when you see that, that is good for our business. That is not an end market, it is really an end use. But I think that is one plus.

In terms of exports, I really don't have any concrete information other than again a gut feeling with the dollar as weak as it is, it has got to be helping people sell more product offshore. Quite frankly, we don't have any systems in place that I could measure that.

That is fair enough. A quick housekeeping question. In the year ago quarter, I think you had some last residual pickup from Midland for the comparisons that benefited from that. Was that meaningful or was that (multiple speakers)?

No, diminimus.

And then last question, back to use of cash, you've got $90 some odd million of cash on the books. Prices are being implemented quicker than we would have expected. You're generating therefore more cash. Is there the possibility somewhere down the road that we would maybe seeing you accelerate share repurchase or dividends? Help us -- give us some of the color into what you're thinking about in terms of the use of cash again.

What I've always stated is that our number one objective is to create shareholder value. And one of the ways to do that is to use that cash wisely. And longer-term, without putting any bounds on it, we think the best use of cash -- free cash is either share buyback or dividends, with dividends coming first. And then any excess cash, share buyback is a good vehicle because you can flex that. Really when you set a dividend people have an expectation that it is permanent, and that has always been our philosophy. So you need someplace to swing, and we would use share buyback as a place to swing. But we have made no definite decisions at this point what we're going to do, although it is something that is continually under discussion.

Given the fact that we are now three price increases into the cycle, however long that is going to last, and again given the cash position, would that maybe make for more use of share repurchase, or more priority on share repurchase then (multiple speakers)?

No, our primary priority will be the dividend. But as you know, if you go up X, you can't put 100% X into dividend unless you believe that the business is no longer cyclic. I would like to get to a point where we did declare victory and this was not a cyclical business, but I'm not ready to claim that yet.

Thanks. Good luck in the quarter.

Mark Weintraub from Buckingham Research.

I just wanted to actually flesh out the free cash part of the equation. Can you give us an update on your cap spend expectations? And also are your cash taxes and book taxes pretty much aligned at this point?

I'm going to let Rick take the second part. I will take the first part. We gave guidance at the beginning of year that our CapEx would be about $100 million. Our normal CapEx, the number we plan around, has been 110, and last year it was 120 because we took $10 million and pulled it forward for some energy cost reduction projects, primarily at Valdosta. That 10 million got pulled up, and it is 100 million for this year. And if I had to call it right now, I would say we're going to come in between 90 and 100 million for this year on CapEx.

For next year should we be kind of assuming the 110 number?

110, yes. 110 is our normal number, and I don't see any acceleration of any projects this year, so probably 110 is going to be the number that we plan around for next year.

As far as the tax rates, as I said earlier, the effective tax rates for this year is going to average about 37%. That includes the 35% in the second quarter. It is more like a 37.5 to 38% effective tax rate. We would see our cash tax rate at approximately 33 to 35% for this year. And until we get some pick up in domestic manufacturing deduction credits as that rolls in, it would be about at that amount.

And that rolls in every year. As you know, it is part of the tax law change, and we pick up a benefit for that, but it phases in over a number of years.

Lastly, any update updated thinking on box plant acquisitions? And what is the environment like out there in terms of finding suitable fits?

I wouldn't say there is a lot new. We continually look. Quite frankly, for the last five for five months we have been pretty focused on getting our prices up and keeping our costs down. That said, we did pick up a small sheet plant in Miami this quarter. It is a small acquisition. I would just say less than $10 million.

We acquired some assets of a company. We had our own building and we moved some of our and equipment down there. So as we speak, we've now got a sheet plant in Miami. But that was a small, small addition, but a good addition. We like Miami. It is a growing area.

But there's nothing new to report. We continue to look. I don't think too much has changed in terms of what the criteria is and what we can find. We are just very careful in acquisitions. We take our time. We would probably be criticized for being a little too careful, but that is just the way we do things.

And then just lastly, you comfortable with your leverage or do you still view yourself as being a little unlevered at this point?

I think people that follow us, like yourself, would say that we are underlevered. I would probably agree with that. Part of the reason we are underlevered is that we like to pay a big dividend, and when your underlevered that gives people who bought the stock for the demand I think a little more security, in terms of the security of the dividend, if you will. We will underlevered by normal measures. And I think it fits our strategy and philosophy better. Obviously, that is an arguable point, but that is our philosophy.

Our final question is coming from Christopher Chun from Deutsche Bank.

Good morning. Congrats on the quarter. Can you remind us again what the breakdown is in terms of your fiber sources between recycled fiber and pulpwood?

Yes. We're basically rough, rough numbers about maybe 22%, 23% recycled fiber, the rest virgin. Of that 22, 23% we get about 7% of that fiber from our own box plants, so we are net buyers of maybe 16, 17% recycled fiber in our mix. As I said you know, we are way on our low end that way, and that takes some of the risk -- it mitigates some of the risk with higher OCC prices because of exports of OCC to China. But there are the numbers.

What are you expecting in terms of pulp costs in 3Q?

Flat. The only kicker -- you ever never know where oil prices are going. We are $3, $3.25 gasoline. If gasoline prices stay at that range, I think we will be pretty good. If they go up a little bit, delivering pulpwood is energy intensive in terms of fuel. You never know, but that is what we're looking for right now. We think flat.

We have all seen that the OCC costs have spiked pretty sharply in recent months. Do you have some thoughts on why that is?

Exports, and the fact that the domestic industry for containerboard, you saw the operating rates that came up by FBA yesterday. Linerboard mills are over 100%. And when you're running that hard -- we are fortunate. We have excess pulping capacity at our mills. That is one of the reasons that we can flex our OCC. You've got a lot of producers that dependent OCC. So if they want around to run at 100%, and they have been running at 90, the only place they can get that fiber is OCC. I think in this case you've got both export pressure and domestic pressure with higher operating rates on OCC. And we do expect them to continue to increase.

Finally, if I may, can you comment on how much you're going to gain on a quarter over quarter basis in 3Q from the fact that you're not going to have the maintenance shuts that you did in 2Q.

We had about -- that would be about $0.03. Because what we had is we had Valdosta, and then we had those boilers down at Filer City. We ran the mail but we had to burn gas on those boilers -- we had to burn gas, not coal, on another boiler. Both of our coal-fired boilers are back up and running at Filer, so we're back on coal. Now we do have -- we also had the situation that Tomahawk was down too, but that was only a four-day outage. So rough number $0.03 a share.

There are no more questions in the queue.

Listen, thank you very much for participating in that call. And I look forward to talking to you next quarter.

Ladies and gentlemen, we thank you all for your participation in today's conference. This concludes the program. You may now disconnect your lines. Have a wonderful day.